For many people, a divorce is the largest division of money they will ever go through. On top of that, you often make the decisions under stress and on a deadline. Your attorney handles the legal process. The financial questions, however, often get less attention than they deserve. What is each asset really worth? What will it cost in taxes? Can you live on the result? That is where a financial advisor can help by providing financial guidance through divorce.
Connecticut Divides Property “Equitably,” Not Necessarily Equally
Connecticut is an equitable distribution state. A court can weigh factors such as the length of the marriage, each spouse’s contributions and each spouse’s earning capacity. As a result, the split is not automatically 50/50. Spouses negotiate much of the outcome. So before you agree to a division, it matters a great deal to understand the true value of each asset. Legal questions about how these factors apply to you belong with your family law attorney.
Protect Yourself With Financial Guidance During the Divorce
The months between separation and a final decree are when many financial problems start, so financial guidance through divorce matters early. Either spouse can use joint credit cards, loans and bank accounts, and you can end up responsible for debt the other person runs up. Review every joint account and decide in writing who will pay each bill. Also check your credit report regularly so you see any surprises early.
The mortgage deserves special attention. If one spouse will keep the house, refinancing it into that person’s name protects the other spouse. That way, late payments will not show up on the other spouse’s credit. And if you will rely on alimony or child support, life insurance on the paying spouse can protect those payments. Base the amount on what the future payments are actually worth, not on a round number picked at random.
Not Every Dollar Is Worth the Same
Two assets with the same balance can leave you with very different amounts. As a hypothetical example, compare $200,000 in a savings account with $200,000 in a traditional 401(k). The savings are already after tax. Withdrawals from the 401(k), on the other hand, count as taxable income. So at a 22% federal bracket, that account is worth roughly $44,000 less after federal tax. That figure is before any state income tax.
The same thinking applies to other assets. Taxable investment accounts may carry built-in capital gains. The person who keeps them will eventually pay that tax. The family home may qualify for a capital gains exclusion of up to $250,000 for a single filer. In comparison, a married couple filing jointly may exclude up to $500,000. So the timing of a sale can matter. Pensions have a value today and may also carry survivor benefits that are easy to give away without realizing it. For example, one spouse might keep the retirement accounts while the other keeps the house. That split can look even on paper but turn out uneven once you count taxes.
Dividing Retirement Accounts Correctly
Retirement accounts are often the largest marital asset, and the mechanics matter. To divide a 401(k) or pension, you need a Qualified Domestic Relations Order, known as a QDRO. A distribution paid to a former spouse under a QDRO avoids the 10% early-withdrawal penalty. However, it is still taxable. IRAs work differently and do not use a QDRO. Instead, a transfer made under the divorce decree splits the account. Done properly, that transfer is not a taxable event.
Mistakes here, such as cashing out instead of transferring, can trigger taxes and penalties that you cannot undo. That is why we work with your attorney and the plan administrators to time and handle transfers correctly.
Taxes After the Decree
Your marital status on December 31 determines your filing status. So the date the divorce becomes final affects that year’s return. Under agreements made after 2018, the person who pays alimony cannot deduct it. Likewise, the person who receives it does not report it as taxable income. This changes how spouses negotiate support. Parents also need to agree on child-related tax benefits, since both parents generally cannot claim them. Our advisors prepare tax returns every year. So we look at how a proposed settlement will actually show up on your return, not just on paper.
Rebuilding After the Divorce With Financial Guidance
Once you sign the agreement, the work shifts to building a plan for one household. That starts with a realistic budget on one income. Next, update the beneficiaries on your retirement accounts and life insurance. Otherwise, a former spouse can remain the beneficiary if no one changes it. Our article Have You Checked the Beneficiary Designation of Your Retirement and Other Accounts? explains why this matters. Then update your will, powers of attorney and health care directives. Finally, set an investment mix that fits your new timeline and income needs.
How We Provide Financial Guidance Through Divorce
We are not attorneys and do not replace one. Instead, our role is to provide financial guidance through divorce, starting with an objective financial picture during negotiations. We also coordinate with your legal and tax professionals and stay with you afterward. Because we are a multi-generational family firm, the advisor you work with during the divorce is the same advisor who helps you rebuild. Our divorce financial planning page explains more, or call our Wallingford office at 203-949-1710 to talk confidentially.
This article is for general information only and is not individualized investment, tax or legal advice. Consult your attorney about the legal aspects of your divorce.